SCM
Optimal reorder interval
Continuous-review inventory model,
Safety stock = z x σL = NORM. INV (α,0,1) x √L x σ
Lead time of shipping from factory to Europe = 5 weeks
Cycle service level = 98%
Product cost = $400
Holding cost per year = 30% of product cost
NORM.INV(0.98,0,1) =2.053748911
Average Inventory
= (Q/2 )+ Safety Stock
Order-Up-To Level,
S = s + Q
Factors driving safety inventory
-Replenishment lead time: If lead time is reduced by a factor of k, the required safety inventory will be reduced by a factor of √k
-Demand uncertainty: If σ is reduced by a factor of k, safety inventory will be reduced by a factor of k
-Service Level
Periodic Review Policy
r : Reorder interval (review period)
S: Order-up-to level (base-stock level)
Average Inventory
= (r D/2) + Safety Stock
Comparing Continuous Review & Periodic Review Policies
Factors driving safety inventory in periodic review policy
– Demand uncertainty
– Replenishment lead time
– Reorder interval
– Service level
Periodic review policy is easier and cheaper to implement
Periodic review policy requires more safety inventory than continuous review policy for the same lead time and service level
p = sale price
c = purchase price
s = outlet price or salvage value
Cu = underage cost per unit
Co = overage cost per unit
a = probability that demand will be at or below order quantity
Optimal Decision
expected marginal cost = aCo = a(c – s)
i.Proposals of European factory
Pros | Cons | |
1 | Reduce the lead time and transportation cost | High initial setup cost |
2 | Increase the responsive ability | Less economies of scale |
3 | Improve service level | Increase the uncertainty and cost of raw materials |
4 | Avoid loss sales |
ii.Proposals of better forecasting
Pros | Cons | |
1 | Minimize the inventory level | High system setup cost |
2 | Better production planning | Based on assumptions |
3 | Better material management | Based on the past data |
4 | Effective handling of the uncertainty | Require high term behavioral insight from market research |
5 | Better utilization of capital |
iii.Proposals of more inventory
Pros | Cons | |
1 | Improve service level | Higher inventory holding cost |
2 | Avoid loss sales | Risk of inventory damage or loss |
3 | Higher economies of scale | Risk of inventory obsolescence |
4 | Provide buffer for supply or demand uncertainty | Less cash flow flexibility |
5 | Reduce production lead time | |
6 | Lower the unit transportation cost / per unit production setup cost | |
7 | Fully utilize production capacity |
Factors Affecting Value of Aggregation
1. Demand correlation
-Aggregation reduces demand variant (and thus safety inventory) if demands are not perfectly positively correlated
-Square root law: If demand in different regions is about the same size and independent, aggregation reduces safety inventory by the square root of the number of areas aggregated
-Note that inventory aggregation does not have to physically centralize inventory. Information centralization (virtual aggregation) would achieve the same goal of reducing safety inventory.
2. Coefficient of variation of demand
-Coefficient of variation = standard deviation / mean
-The higher the coefficient of variation of demand of a product, the larger the impact on safety stock reduction as a result of aggregation
3. Value of product
-High-value products will provide a greater benefit from aggregation than low-value items
Levers to Reduce Safety Inventory
-Reduce information uncertainty in demand
-Reduce replenishment lead time
-Reduce supply uncertainty or replenishment lead time uncertainty
-Increase review frequency in a periodic review policy or use continuous review policy
-Physical centralization and information centralization
–Specialization
->Centralize slow-moving products which typically have a high coefficient of variation to achieve the largest benefit of aggregation
->Leave fast-moving, low-value products closer to customers to provide faster service and save delivery cost
-Product substitution
->Substitution aggregates demand across the components and therefore reduces the safety inventory
->The higher the demand uncertainty, the more benefit from the substitution
->If the cost difference is small, one should carry more higher-value components to substitute the shortage of lower-value product
->If demands are strongly positively correlated, there is little benefit of substitution (just as aggregation)
->Joint management of inventories across substitutable products
-Component commonality and postponement
->Component commonality allows the aggregation of raw material inventory
->As the common component is shared by increased number of finished products, the cost of the component or the finished products that use the component increases as it requires more flexibility from the component or the product design
->By postponing product differentiation or customization until closer to the time the product is sold, the producer would have common components in the supply chain for most of the push phase.